The recent uncertainty in the market that appeared as a result of the Fed’s initiatives and volatility in emerging markets sent the Standard & Poor’s 500 Index to its lowest point since the beginning of the year, which has dominated stock market news. The correction may not be completely over, but it has still helped to develop some interesting new opportunities. The recent selloff in the market put many solid companies under pressure and as a result their stocks dove to new, low levels after reaching somewhat overvalued highs in 2013.
Although we are still cautious, the market does seem to be on a roll again. This is the right time to be evaluating firms that have pulled back but have solid fundamentals, positive long-term trends, and a defensible position in their industry. Much like our trade on Tupperware Brands (TUP) (recommended two weeks ago), Bed Bath and Beyond (BBBY) represents that kind of opportunity.
A specialty retailer of household linens, décor and small furnishings, BBBY saw its stock rise 300% since 2009 from $20/share to around $80/share by the end of 2013.
BBBY had a disappointing January when the share price dropped from $80.00 to a low of $62.00, a 22.5% decline in a single month. Bearish pressure across retail combined with an earnings report that missed top and bottom line forecasts drove the stock below its 2013 trading range to where it is now. The question at this point is whether BBBY will be able to turn expectations around in 2014?
The drop in BBBY should have been seen well in advance. Over the last several months, housing data have been looking worse as interest rates began to rise in May 2013. Most recently, the National Association of Home Builders reported in its sentiment index that order flow and the future outlook has dipped back into contraction territory. This is a problem because names that make the stock market news like BBBY, Home Depot (HD), Whirlpool (WHR) and others do better in economic conditions when housing is booming.
Labor data has also been dipping recently according to the Bureau of Labor Statistics at the Department of Labor. Job growth, consumer spending, and retail success are closely correlated and unless job growth picks back up in 2014, retailers in general may be in trouble. This factor should have also warned investors that BBBY’s January report was a potential disappointment.
Unsurprisingly, stock-prices for retailers mirror operating performance, which is affected by the macroeconomic environment and company-specific factors. Despite fears to the contrary, the recent volatility in the market has not been driven by underlying economic weakness. Yes, there has been some slowing in the housing market but it’s not anything like what we experienced in 2006-2007. The most recent correction is relatively minor compared to other bearish moves over the last five years. In general, economic growth looks strong enough to offset the risks we are watching in the economy and housing.
Despite the “poor” performance in this last earnings report, BBBY is still wildly profitable and is in a better cash position than its peers. Growth is still expected to be more than 5% this year. When compared to its five-year average (over 10%) that seems pretty low but we consider this contrast to be a sign that the company is “sandbagging” its forecasts to avoid another disappointment.
Past performance is the best predictor of future performance because it’s the only data we have. Historically speaking a company that has been growing at the rate BBBY has over the last five years is more likely to re-accelerate their growth in the near term than they are to settle into contraction or flat performance. Price and fundamental trends tend to be persistent.
This will allow BBBY to continue its share buyback program and should continue to motivate underlying support from value investors. It’s not uncommon to find price shocks like this in the stock market news, fundamentally sound stocks are the most likely to later ‘fill the gap’.
Share buybacks can be a mixed bag. Companies tend to do them at exactly the wrong time because they have cash to execute a buyback when their shares are at historical highs. However, expanding the buyback program (or merely continuing at the current pace) would make this exactly the right time to buy shares while they are at a low.